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Tuesday, July 5, 2016

Brexit and its Impact on International Trade and the manufacturing industry in the UK

In the previous two articles we
covered the potential Brexit impact on immigration and public finances. Now,
lets look at the likely impact of Brexit on the UK’s International Trade and
Manufacturing Industry.

We will start off by looking at Britain’s
current trade links with the European Union. Then we will look at the potential
trading relationship that might follow Brexit. Then we will assess the cost of
leaving the Single market and even look at potential benefits of Brexit to
Trade.

Britain’s Current
Trade Links with the European Union

The United Kingdom’s trade links with
the European Union are considerable. Official trade statistics show that the
European Union is the destination of about half of all British goods exports.
Of course, this is just the UK nations. If we take into account the various
countries that have a free trade agreement with the EU (And trade with UK as a
result) the % of Britain’s exports that is linked to the EU membership goes up
to around 65%.

So, if we take into consideration the fact that Exports account
for about 30% of the British GDP, the value of the exports linked to EU
accounts for at least 15-20% of the overall UK Economy.

Potential Trading
Relationship between EU and UK

Let me start off by saying that the
potential trading relationship between the EU and the UK will be similar to
what they have now and the chances of the UK getting a favorable trading
agreement post Brexit are very high.

Reason: British Markets are equally
important to the rest of the EU.

If you take the overall share of the
rest of EU exports going to UK, it is about 18%.

If you take the % share of the
exports from major EU nations that end up in the UK, it paints a slightly
different picture. Look at the picture below:

As you can see, except Germany, UK is a very important market
for most of the large EU economies. So, it is equally important for the EU to
negotiate a favorable trading deal with the UK. Also, given the fact that the
EU is currently negotiating free trading agreements with countries that are far
less important to it from a trading point of view, it would be crazy if they
don't end up reaching a good deal with the UK.

On a related note, the chances of countries that have a free
trade agreement with EU, continuing the same with the UK post Brexit are
relatively high too.

What Options does UK have to gain Access to the EU Single
Market?

The European single market is more
than just a free trade agreement between member nations without tariffs. Goods
can move freely because all members adhere to common regulatory requirements
and technical standards. In addition, the single market provides for the free
movement of services, capital and people.

Post Brexit – the UK could go two
ways in trying to maintain this free access to the EU Market.

Option 1: Be a Member of European
Economic Area

Britain could in effect remain part of the single market by
becoming a member of the European Economic Area. Norway, Iceland and
Liechtenstein are outside the European Union, but in the European Economic Area
and hence enjoy access to the single market.

Of course, this is something that the people who voted in favor
of Brexit wouldn't prefer. The whole point of leaving the European Union would
be to gain substantial extra freedoms; which in this case would not be possible.

Option 2: Follow the Switzerland Model

The Swiss are members of the European Free Trade Association but
not the European Economic Area. They have established free trading relations
with the EU and have access to the single market through a series of bilateral
agreements. This could be a more preferable approach for the Brits who voted in
favor of Brexit but would require tough negotiations because if the EU goes
soft on the UK, it could open the door for further exits by member states which
the EU wouldn't want.

Single Market – In or Out?

Assuming Britain does not remain in
the single market, then even if the United Kingdom managed to negotiate a free
trade agreement, exporters would face additional costs in selling into the
European Union. These would include extra costs of clearing customs and the
administrative costs of complying with the European Union’s rules of origin.

The important fact is that other countries, such as the United
States, manage to export successfully to the European Union despite facing
these barriers. Plus, it is very easy to forget that the remaining 50% of
exports from the UK are actually to Non-EU nations in spite of additional
overheads like customs clearance, duties etc.

With the single market as it stands
today, the United Kingdom needs to apply European Union regulations to the
whole of the economy. For example, the National Health Service must comply with
the Working Time Directive and retailers are affected by the Agency Workers’
Directive from the EU. These can be dropped by the UK if they feel they are redundant
or are not in alignment with their national policies. Nevertheless, the
benefits of getting rid of EU regulations should not be overstated because, Britain
would probably want to keep many of them anyway for ease of operation.

For Ex: To be able to trade freely
with the EU, manufacturers in the UK would still have to adhere to European
product standards. If the UK decides to adopt a different set of standards,
then the manufacturing cos would have toproduce the same goods in one way to meet the EU standards and the
others in another way. This would be an inconvenience and following the EU
Standards would make lives much easier & simpler for the Brits, wouldn't
it?

Brexit – Worst Case
scenario

The worst case scenario for UK post
Brexit would be one in which the UK fails to negotiate a free trade agreement
with the EU. Such an outcome might result from the Union playing hard ball in
order to discourage any other members from leaving or, alternatively, the EU may
demand too high a price; such as the continued free movement of labor which the
Brits may not agree.

Nevertheless, even in that
pessimistic case, the losses for British trade or manufacturing industry would
not be catastrophic. If it transpired, British exports to the European Union
would face the latter’s common external tariff. This is sometimes called the
‘World Trade Organization option’, as the United Kingdom’s trade with Europe
would be governed by the ‘Most Favored Nation’ rules.

Anyways, there are a few reasons why
this worst case scenario may not be catastrophic for the UK.

Firstly, tariffs have fallen substantially as part of a
world-wide trend towards reducing trade barriers. The average tariff under the
Most Favored Nation tag is just 4%. For starters, a 4% extra cost doesn't sound
like too much isn’t it? On top of this, the GBP has been a very strong currency
and could potentially offset a good chunk of this fee if the destination
currency is weaker. However, this won’t be the case for all sectors. For ex: The
tariff for some of the food and dairy product categories carry a tariff ranging
from 10% to up to 50%. For such manufacturers, the Brexit impact could be much
higher than those who fall closer to the average tariff range.

Of course, from the other side, the UK could start imposing its
own tariffs on imports from the EU. The reason I want to make this point is
because many of the EU nations have sizeable experts to the UK and if the EU
plays hard ball with the UK, they can try and return the favor to make things hard
for everyone involved. But, at the end of the day, this escalation of trade
barriers would clearly have a detrimental effect on all parties involved.

But if the European Union steadfastly stuck to its decision to
raise tariffs, then it would be in the United Kingdom’s best interests to
nonetheless maintain its own free trade position vis-à-vis the European Union.

Nevertheless, those countries which
have a free trade agreement with the European Union generally have higher
tariffs than 4%. For example, the United Kingdom would face an effective tariff
to Egypt of 35%. However, Britain should be able to negotiate its own
agreements with those countries. Even if not, the countries with the highest
tariffs are generally small markets for the United Kingdom.

Secondly, the % of Exports from the UK that end up in the EU has
been consistently coming down. Over 60% of the Goods and Services produced in
the UK ended up in the EU at the beginning of the year 2000 but the number is
closer to 50% now. And to put things in perspective, this reduction in % is in
spite of the membership expansion of the EU with newer nations joining the
fold.

As you can see, the worst case scenario wouldn't hurt the UK
today as much as it would have a few decades ago.

The government may choose to use the savings from its
contributions to the European Union budget to compensate the hardest hit
sectors (including some manufacturing industries) and regions, at least in the
short term.

Are there any
Benefits in Leaving the EU?

The Proponents of the Brexit Movement have long been arguing
that leaving the EU will be beneficial for the UK. Of course, they wanted to
drive their agenda and hence will claim it will be beneficial but does the
argument hold any merit?

Talking purely from a Trade perspective, leaving the EU could
actually create long term opportunities for the UK. They can boost their trade
with other countries by signing their own trade deals with non-EU countries. In
the recent years, export growth for the UK has in fact come from outside the EU
and if the UK can sign sweet deals with other nations, this could potentially
be a game changer for the UK industries. This kind of negotiations with non-EU
nations is presently not possible because trade negotiations can only be
carried out for the EU as a whole. There are many countries with whom EU
doesn't have a good trading deal and it could be easier for the UK to
individually reach out to them and sign deals rather than EU as a whole.

To make things better for the UK, they
could even reduce the tariffs on imported goods from those non-EU nations in
return for favorable deals for exports. This would boost domestic production
and make UK a better & more profitable manufacturing destination than the
EU (If they reduce their tariff to be lower than EU figures)

Of course, on the flip side, the
opponents of Brexit argue that countries would not want to negotiate trade
deals with UK on its own because its contributes a very small % to the global
output. But, reality is, it would definitely be easier and quicker for
countries to negotiate a trade deal with the UK than it is with the EU. The
Swiss have been successful in negotiating free trade agreements better than the
EU has been and there is no doubt UK will be able to, considering the fact that
most non-EU nations have some sort of history with the UK.

Striking new trade deals and, in turn, opening up fast growing
markets outside Europe and improving the competitiveness of Britain’s
manufacturing industry and goods exports would be likely to help rebalance the
economy away from its current reliance on services. In 2014, Britain had a
goods deficit of £121.2bn and a surplus on its services trade of £85.9bn.
Hence, services play a disproportionate role in supporting Britain’s trade
account. Boosting exports of goods could help in strengthening the United
Kingdom’s current account and creating a well-balanced economy.

Some Last Words

The opponents of Brexit have always
suggested that an exit from the EU would spell doom for the manufacturing and
trade industry in the UK. As you saw just now, the figures have been
exaggerated. Some statements like Trade between EU and UK may cease makes me
wonder how much these guys know about the trade relationship between the UK and
the EU. The UK needs the EU almost as much as the EU needs the UK and neither
can afford to mess with the other and get away unscathed.

Of course, the section on
Opportunities or Benefits of Brexit is all conjecture based on assumptions that
the UK would be able to strike up good trading deals with the EU as well as
with rest of the world.

Nevertheless, contrary to the claims
of many folks both in favor of and against Brexit, it is entirely possible that
the Impact of Brexit on Trade would be relatively small.

Lets see how things unravel…

Disclaimer: All views presented in this article are those of the Author and are not endorsed by anyone. While every effort has been made to ensure that the data quoted and used in this article is reliable, there is no guarantee that it is correct, and the Author accepts no liability whatsoever in respect of any errors or omissions. This article is only economic research and is not intended to constitute investment advice, nor to solicit dealing in securities or investments.

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